With M&A activity showing little sign of slowing, and emphasis on nonfinancial priorities growing, leaders need to retool their due diligence practices.
Why dealmakers need to be ESG-vigilant
March 9, 2023
The 4,410 senior executives who participated in PwC’s latest Global CEO Survey are doing a number of things to insulate their companies against economic volatility, from reducing costs to raising prices. One thing a solid majority of them (60%) are not doing is pulling back on dealmaking. But while global M&A activity may be robust, the nature of many of those deals is changing. Just a few years ago, environmental, social and governance (ESG) issues were largely the concerns of activist stakeholders and forward-thinking regulators. Now these topics are maturing into a set of due diligence criteria with important implications across the M&A landscape. As the scope expands to include a broader range of non-financial priorities and metrics, dealmakers need to watch out for six “orange flags”—potential hazards that may not stop a deal but require proceeding with caution:
- Unethical marketing. Look out for messages that are inconsistent with reality, meaning that they don’t align with regulation, stakeholder sentiment or public positions taken by acquirers. Be attuned to inconsistencies in public messages and the efficacy of products, especially in industries where marketing regulation is loose.
- Reputational risks. As has been well established by recent high-profile greenwashing accusations in the corporate world, failures to meet regulations, internal targets and stakeholder expectations can lead to negative attention, knocks to consumer and client confidence, and loss of revenue. Forward-thinking diligence on reputation involves gaining a more robust understanding of a firm’s value proposition in terms of market focus and potential, and verifying a wider set of ESG claims.
- High risks in supply chains. Even as conflicts, trade tensions and weather disruptions persist, the scope of due diligence around supply chain relationships is expanding: modern slavery, health and safety, and labour rights have grown in importance, as has the sourcing of raw materials.
- Disengaged employees. Employees, who are often an important voice for the legitimacy of a company’s ESG credentials, continue to be a critical asset at the centre of most deals. Dealmakers are increasingly looking to diagnose staffing losses through specific assessments of social and governance issues, examining areas such as company culture and employee satisfaction. If an acquirer’s talent practices cause workers in the target company to leave, that destroys value.
- The transformative deal that isn’t. Achieving progress in the ESG transition brings risks, especially if outcomes are overpromised or underdelivered. Take the creation of ‘green jobs’ as part of the wider just transition. In OECD countries that are undergoing a construction and infrastructure boom, the construction workforce is predominantly male. As the energy transition occurs and roughly 20 million new green jobs are created, green jobs will likely lean to men rather than women, exacerbating one imbalance even as dealmakers seek to resolve another.
- Inadequate nonfinancial disclosures. A recent PwC survey showed that 87% of global investors thought corporate reporting contains greenwashing. Certainly, inadequate disclosures create regulatory or reputational risk. But if an acquiring company also fails to envision that a high-warming scenario would create serious physical risks for a target, or an accelerated-decarbonisation scenario would create significant transition risks, they could miss out on a lot of value. Ultimately, companies will need to disclose more information, as stakeholders demand greater transparency and regulatory thresholds are heightened. But in the meantime, dealmakers seeing orange flags around disclosures will want to value targets under various ESG scenarios, using accurate climate change models.
Learn more about how to create value in an M&A environment being profoundly changed by ESG.
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